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National stereotyping is not an explanation for boom-bust – it is mostly about luck

A couple ofweeks ago I visited Lithuania and around a month ago I was in Ireland. Both countries have been through boom and bust and both countries are still not out of the crisis. Tomorrow I fly to another crisis hit place – Dubai. This has reminded me about an issue that have been on mind my mind for some time. Can national stereotyping explain why countries are hit by crisis? My clear answer is no and that should be the answer of most intelligent people. However, surprisingly often both mainstream media and many economists would hint (or say directly) that national characteristics can explain why X or Z country has been hit by crisis.

How often have we not heard that Greeks are lazy or Icelanders are natural risk takers etc. In Michael Lewis’ otherwise excellent new book Boomerang he often uses cultural explanations for why for example Iceland got hit by crisis in 2008. I am not completely neutral on the Icelandic case and I am one of the “sources” and I was quoted on the story in Michael’s book, but I must say that the Icelandic crisis has very little to do with the national character of Icelanders. Yes, there are specific Icelandic issues that can help explain why things ended so badly in Iceland – for example that it is a very small country, which probably meant that regulators and local investors did not have enough knowledge to fully understand the risks, but this has nothing to do with Icelandic “culture” or the national character. Hence, I believe that these national stereotypes have very little explanatory power.

In my view there is another more important, but less fanciful explanation for most crisis and that is the simple one that some nations are simply more lucky or unlucky than others. Hence, even for countries where the institutional set-up is good and the incentives to do the right thing accidents do happen. And the other way around – even countries with highly irresponsible policies can escape crisis if they are lucky.

A good example of this is Norway and Iceland. Icelandic and Norwegian culture in many ways similar and the two countries share a “Viking-history”, but today many would talk about irresponsible Icelanders and about the prudent Norwegians. What’s the difference? Well, Norway has oil and Norway had banking crisis – not very different than the Icelandic crisis – in the early 1990s so bankers and regulators were probably more aware of the risks than was the case in Norway. This is basically about luck about natural resource and the timing of banking deregulation.

Another example is Lithuania and Bulgaria. Both countries are Emerging European economies with fixed exchange rate policies and both countries have gone through boom-bust. Furthermore, both countries’ policy response to the crisis has been more or less the same. The fixed exchange rate policies have been maintained and fiscal austerity measures have been implemented. There are of course differences, but overall the two “cases” are pretty similar, but the strength of the recovery in the two economies has been very different. Lithuanian has grown surprisingly strong in 2011 (probably around 6% y/y GDP growth), while there basically not been a recovery in Bulgaria. Why this difference? My explanation is that it is mostly about “geographical luck”. Lithuania’s main trading partners are the Nordic countries, Germany, Russia and Poland – all countries that have seen relatively strong recoveries. At the same time Scandinavian banks dominate the Lithuanian banking sector. On the other hand Bulgaria is neighbouring crisis-hit Greece and the Greek banks (and Italian banks) play a key role in the Bulgarian banking sector and trade links to Greek are significant.

It is not only when it comes to failure that national stereotyping is often used. The same comes to the success stories. Today we all the time hear about how fantastic the Chinese are and how fantastic Chinese economic “management” is. This despite of the fact that China by any normal standards is a relatively underdeveloped country in terms of wealth and welfare. On a GDP per capita basis China is far from a rich country. Similarly if anybody bother to remember back in the 1980s everybody were talking about a special Japanese management model and that soon the Japan would dominate the world politically, militarily and economically because the Japanese were culturally superior to Western Europe and the US. Whatever happened to that idea??

So culture and national stereotypes tells us very little about economic success and failure. Bad policies and luck is normally the best explanation. It is just much less colourful and “luck” does not really sell books or newspapers.

PS talking about luck back in 2006 Lithuania failed to be allowed into the euro zone because the inflation rate was 0.1%-point too high. Was that luck?